INVESTMENT FOCUS-Once wary markets warm to Merkel status quo

January 18, 2013|Reuters

By Mike Dolan

LONDON, Jan 18 (Reuters) - As the euro crisis raged at itspeak just over a year ago, few global investors reckoned AngelaMerkel's re-election as German Chancellor this year was likelyor even desirable.

Now they appear to be assuming both - thanks partly to hergaffe-prone Social Democrat opponent but perhaps as much or moreso to European Central Bank chief Mario Draghi and his successin stabilising the teetering currency bloc last year.

As Sunday's state elections in Lower Saxony give investorsan early glimpse of how September's federal elections may playout, Merkel has a commanding poll lead over Peer Steinbrueck asGermany's favoured next Chancellor.

The constellation of coalition government she will be ableto form is far more in question, but investment strategists seestatus quo in the chancellery at least as the best bet forsustained rehabilitation of the battered euro bloc, and, byextension, economic stabilisation home and abroad.

Sunday will show whether Merkel's Christian Democrats (CDU)and Free Democrat (FDP) allies - now neck and neck in opinionpolls with the centre-left pairing of Social Democrats andGreens - can hold the country's fourth most populous state andherald a turnaround after drubbings in 12 regional electionssince 2009.

For overseas money managers who claim to see few majordifferences between the two sides on critical euro or domesticeconomic policies, the familiarity of Merkel's existinggovernment and her crisis management now seems to offer greatercomfort.

And yet this has only really taken shape since last July,when Draghi's "whatever it takes" pledge to defend the euro defused the explosive sovereign debt crisis.

Back in 2011, investors fretted about whether Merkel and hercoalition had the will, the plan or the public backing to keepsupporting Greece and other ailing euro governments whilestaying committed to the euro via deeper integration.

Euro stabilisation - which has almost halved Italian andSpanish borrowing costs from their respective crisis peaks overthe past 16 months - has fed Merkel's domestic popularity andthe rebound in her popularity now looks as if it may reinforcethe euro recovery.

And despite the recent slowing, the German economy itselfremains impressively near full employment while German stockprices gained a whopping 30 percent in 2012.

"To simplify it a lot, Merkel's popularity has beeninversely correlated with the yields on peripheral euro bonds,"said Alex Godwin, Global Head of Asset Allocation at CitiPrivate Bank in London.

"Arguably, the biggest supporter of Merkel's re-election hasbeen Mario Draghi. By staving off a disaster and stabilising thesituation, he has made the last two years of euro zone politicslook much more successful than it seemed at the time."

Godwin said what's become clearer to outside observers overthe past year - and perhaps to many German politicians too - isjust how much German public opinion still favours holding theeuro together, for all its wariness about endless bailouts.

"Germans seemed genuinely scared of the prospect of a Greekexit or euro collapse," he said. "And anti-euro rhetoric orbailout opposition has never really chimed with the electorate.So Merkel's 'carrot-and-stick' approach is the balance that mostinside and outside the country are happiest with."

Franz Wenzel, chief investment strategist at AXA InvestmentManagers in Paris, feels the full-term review of Merkel outsidethe country very much tallies with her surging poll ratings.

"Investors would now be worried about a government withoutMerkel," he said. "She has done a fairly good job in a verydifficult period, she's been a guarantor of the euro zone, asafe haven in a turbulent environment, and the German economy interms of key employment metrics still looks fine."

COALITION MATHS

Others are more worried about coalition maths, however, andthe implications for a new Merkel-led federal government laterthis year. This is why Sunday's regional poll may act as abellwether.

"If she did badly this weekend, then it could surprisemarkets and unnerve people about how the smaller parts swing thenext government," said Peter Westaway, chief European economistat fund manager Vanguard, adding that this would affectperceptions of policy timing and volatility rather than basicassumptions about European policy.

If the SPD and Greens do take Lower Saxony, some analystssay their increased strength in Germany's upper house, theBundesrat, could frustrate and block more legislative proposals.While some reckon this is already possible anyway, Commerzbankanalysts say a formal blocking majority could give theimpression of a "lame duck" federal government before September.